naked capitalism

Just a few weeks ago, experts were saying the credit crisis was on the mend and we could all get back in the pool. But as we discussed in an earlier post, worries about Fannie and Freddie are on the rise, and the increase in agency spreads back in January was probably the biggest trigger of the last acute phase of the credit crunch that peaked in March with the bailout of Bear Stearns.

Bloomberg reports that former Fed president Richard Poole said the GSEs are insolvent and that Congress needs to recognize this fact. This is, needless to say, a provocative statement, particularly from a former regulator. The officialdom generally accepts the premise that more than a little dissembling is OK if it keeps the great unwashed public from worrying about things that are deemed to be beyond them.

But Poole didn’t respect that convention even during his term. He has long been a critic of the half pregnant status of the GSEs. In 2003, he rattled markets by saying the government should strip them of their implied backing (some readers point out that Fannie and Freddie securities clearly say that they are not guaranteed by the government but their prices say the world at large thinks otherwise) and in 2006 and 2007 said their charters should be revoked.

From Bloomberg (hat tip Dwight):

Borrowing at Fannie Mae, the government-sponsored mortgage company, has never been so expensive and it may not get better any time soon.

Fannie Mae paid a record yield relative to Treasuries on the sale of $3 billion in two-year notes yesterday amid concern the biggest provider of financing for U.S. home loans won’t have enough capital to weather the worst housing slump since the Great Depression. The company’s credit-default swaps show traders are treating the AAA rated debt as if it were five steps lower. Fannie Mae shares tumbled 13 percent yesterday in New York to the lowest level in almost 14 years.

Chances are increasing that the U.S. may need to bail out Fannie Mae and the smaller Freddie Mac, former St. Louis Federal Reserve President William Poole said in an interview. Freddie Mac owed $5.2 billion more than its assets were worth in the first quarter, making it insolvent under fair value accounting rules, he said. The fair value of Fannie Mae’s assets fell 66 percent to $12.2 billion, data provided by the Washington-based company show, and may be negative next quarter, Poole said.

“Congress ought to recognize that these firms are insolvent, that it is allowing these firms to continue to exist as bastions of privilege, financed by the taxpayer,” Poole, 71, who left the Fed in March, said in an interview…

“At some point we’re going to reach that inflection, where the government is going to have to either guarantee explicitly or Fannie and Freddie are going to have be left to fend for themselves,” Peter Boockvar, an equity strategist at Miller Tabak & Co. in New York, said in an interview with Bloomberg Television. “We’re getting to that point where a decision has to be made by Washington.”…

The government is counting on Fannie Mae and Freddie Mac, which own or guarantee about half the $12 trillion in home loans outstanding, to help revive the housing market. Congress lifted growth restrictions on the companies, eased their capital requirements and allowed them to buy bigger “jumbo mortgages” to spur demand for home loans as competitors fled the market.

Paulson said on July 8 he was pleased with Fannie Mae and Freddie Mac’s efforts to raise capital. Bernanke said the same day the firms need to be “strong, well-regulated, well- capitalized” to provide credit “without posing undue risks to the financial system or taxpayer.”….

Congress created Freddie Mac and expanded Fannie Mae in 1970 to promote home buying in the U.S. The companies’ charters give the Treasury the authority to buy as much as $2.25 billion in each of their securities in the event of possible default.

The government will likely be forced to take over the companies because of the mortgage meltdown, Poole said.

“We know in a crisis the Federal Reserve tap would be open,” said Poole, now a senior fellow at the Cato Institute…

“I worry about those institutions,” retired Richmond Fed President Alfred Broaddus said. “They are huge. They dwarf the Bear Stearns issue. In the very worst case scenario, I don’t know how you do it other than extend money and the public takes the loss.”…

The companies have access to the Fed’s so-called Fedwire payments system allowing them to access funding if needed, said Vincent Reinhart, the Fed’s chief monetary-policy strategist from 2001 until September 2007.

They can withstand the slump in part because most of their investments are mortgages made before 2006 when lending standards were tighter, making them less likely to default, said Eileen Fahey, a Chicago-based analyst at Fitch Ratings.

“We do not believe they are technically insolvent,” Fahey said. “People seem to lose sight of the fact that a majority of the mortgages that they are holding and are guaranteeing were originated pre-2006.”